Oil Majors Double Down On Refining

The oil majors are increasingly betting their futures on a mix of downstream enterprises. Refineries, processing, petrochemical facilities and retail gasoline stations are gaining in importance, while upstream spending stalls.

The WSJ reports that BP has plans to open 1,000 retail gasoline stations in Mexico and India over the next three years while ExxonMobil has massive investments tied up in refineries along the Gulf Coast. Other oil majors have similar plans, while also stepping up bets on renewable energy. The IEA estimates that the oil industry will add 7.7 million barrels per day of new refining capacity by 2023.

Refining is in some ways a safer bet than major outlays on upstream exploration. Spending tens or even hundreds of millions on exploring in deepwater could result in dry wells. Pouring that money into downstream ventures has a more certain payoff. Over the long-term, price volatility for crude adds risks to new upstream projects, but solid demand (for a while, at least) makes refining investments a little safer.

“Upstream at some point was not making money,” Tufan Erginbilgic, head of BP’s refining and retail unit, told the WSJ.

Global upstream spending peaked at $900 billion in 2014, but the crash in oil prices cut that figure nearly in half by 2016. Spending has only rebounded a bit since then. Rystad Energy estimated that the oil industry would only be spending about $510 billion in 2018.

Unsurprisingly, that translated into a record low volume of new oil discoveries last year at about 7 billion barrels of oil equivalent. In 2017, the global oil industry only discovered around 580 million barrels of oil equivalent on average each month, or a rate that was about 10 times smaller than it had been five years earlier.

Now, oil prices are at their highest level in years, opening up a lot more room for higher levels of spending. But most oil companies are approaching the upswing with more caution than they might have in previous cycles. Shareholders are demanding spending restraint, forcing a strategy overhaul for many in the oil industry.

Companies that are returning cash to shareholders, such as Anadarko Petroleum, have been rewarded by Wall Street with higher share prices. On the other hand, companies looking to ramp up spending, such as ExxonMobil, have been beaten down over the past year (although higher oil prices are now boosting the entire industry).

Still, while ExxonMobil has big plans for spending on offshore drilling in Guyana and shale drilling in the Permian, a third plank of its core long-term strategy is downstream and petrochemicals.

The timing is opportune for such downstream investments, particularly along the Gulf Coast. The Permian basin is gushing new supply, which is growing with each passing day. That provides an abundant feedstock for refiners in Texas and Louisiana. The location along the coast also allows for products to be exported abroad.

Sweetening the pot is the fact that WTI is suffering a steep discount relative to Brent, which fattens margins for refiners. They can buy up cheap WTI crude, process it, and export products that are priced closer to Brent. It all amounts to simple arbitrage.

In addition, there is going to be a need for new refining investment as refiners struggle to process the flood of light sweet oil coming from the Permian. "Our thesis is that the U.S. refining system is close to being maxed-out on the amount of shale oil it can process," wrote Morgan Stanley equity analysts in April.

ExxonMobil said in March that it would spend billions on several refining upgrades along the Gulf Coast to scale up capacity to process light sweet oil from the shale patch. Overall, Exxon has plans to spend $9 billion on six refinery projects around the world over the next eight years, investments that the company says will allow downstream earnings to grow by 20 percent.

Petrochemicals are also held up as an important hedge against shaky demand forecasts. Oil consumption in transit could begin to fade, but analysts are more bullish on plastics and other petrochemical products. Demand for petrochemicals could rise by 60 percent between 2016 and 2040, while demand for oil in road transportation is set to rise by around 8 percent, according to an IEA forecast from last year.

In a scenario in which tighter environmental regulations eat into oil demand, the IEA argues that transportation fuels will suffer much more than petrochemicals.

Overall, in most conceivable scenarios, the IEA sees petrochemicals taking over as the main driver of oil demand growth in the years to come. The oil majors see the writing on the wall.